Wednesday, December 16, 2009

These two charts show year over year changes in the consumer and producer price indices, the top chart showing total, or "headline" inflation, while the bottom chart shows just "core" inflation (excluding food and energy). Energy prices are a big part of the current headline numbers, as the difference between these two charts illustrates.

Looking at all prices, inflation has jumped rapidly from negative to back to where it was on average over the past decade or so (about 2%). But on the margin, the jump is even more impressive: in the past six months, consumer prices are up at a 4.2% annualized rate, and producer prices are up at a 8.3% annualized rate.

Looking at core prices, inflation is subdued, with the Core CPI rising at a 1.5% annualized rate in the past six months, and the Core PPI rising at a 0.7% rate.

If you're willing to ignore energy prices, then you could agree with the Fed that inflation is far from being a concern these days. If not, though, then you would be pounding the FOMC table today to reverse the quantitative easing ASAP.

I'm willing to concede that energy is indeed volatile, and since energy prices are down this month relative to last month, that their impact in future inflation statistics is going to be minimal. But I continue to believe that the level of core inflation is "the dog that didn't bark," in the sense that it should be far lower than it is, if the Fed's theory of inflation is correct. The economy is still very weak, and there is an awful lot of "resource slack" out there. If resource slack is the thing the Fed is betting on to keep inflation subdued for the foreseeable future, then the Fed governors ought to be pretty nervous right now, because the Core CPI is only half a percent below the Fed's upper target of 2%. The bond market ought to be more nervous too, since breakeven inflation rates on TIPS maturing in 5 years or less is 1.5-2%.

I doubt the FOMC will acknowledge this reality in its statement today, but if they did I would feel a lot better about things.

This chart of inflation reminds me of charts showing global temperatures are up 0.2 degrees in the last 100 years, and thus we are cooking to death. Really?

Forget inflation. Ain't happening.

There is a huge global "excess" of investable capital, that roams the globe and asset categories, in search of returns. If a portion of the global glut piles into gold and gold funds, then you get a gold blip. If housing is hot, then housing goes up. Oil, then oil. We may see booms and bust in investments categories, but we are certainly seeing none in wages (60 percent of costs), office rents, factory rents, energy, phone service, any gadgets--indeed much is getting cheaper.

Here is wild one for you: A guy can rent an office in downtown L.A today, and have a cheaper office and phone service than in 1979. Add to that, if that guy has any brains, he no longer needs a secretary (answering machines, online e-mails etc).

Gold?

It was Fool's Gold in 1986 and it is Fool's Gold now.

Look to Asia. A long, long term boom well underway, and will continue for decades. Money will be made like never nedofe in the history of man.

New technical accomplishments will top anything we have seen so far easily.

Benjamin: I would note that wages are the last thing to go up in an inflation. I understand your points, but I'll stick with my view that inflation is going to be higher than the market expects. Even if it only rises to 4-5%, that is a big deal. That can add up over time to some significant price changes.

I don't see costs going down except for milk and pork. There is very little slack in the economy. There are no jobs for the unemployed to go back to. What will happen when the manufacturing sector picks up? Staffing levels and inventories are at rock bottom levels. People will have to be hired off the street and trained. Cash will be needed and the banking sector will be unable or unwilling to supply it because the banks are too fragile to do anything but invest .25% federal funds in LT treasuries. People who now have jobs will have the bargaining power to to maintain their purchasing power as the price of imports rises. Yes, there can be inflation with 10% unemployment.

People do not understand how severe the distortions in the economy are that 12 years of economic mismanagement created. There is a mismatch between the skills and location of the labor force and the jobs that will be created if this economy is to grow. Vast amounts of capital have been squandered. So what if vacant office space in LA is now cheap. Office space has been even cheaper in Youngstown, OH for decades.

One also has to take into account the micro-economic environment the Democrats and the Obama Administration have put into place. Every day they throw up new barriers to economic growth and threaten to do worse.

It is indeed possible to hit the accelerator and the brakes hard at the same time. What happens is the engine revs and the car goes nowhere - rising unemployment and rising prices.

Scott: Yes, labor is a lagging indicator--but my guess is that outside some skilled groups, there will be no wage inflation for years. And wage inflation really hasn't happened in years and years anyway. The fraction of the private sector labor force that is unionized is hardly worth mentioning anymore. I will concede that public unions have grabbed too-rich deals, and need a crank-down btw.

Charles-

I see a lot of slack in the economy, not very little. Everybody wants more business. Now wants--needs.

There is nice office space renting for $2 a sf in Los Angeles now--less than the $3 some nice space reached in 1979. That is an astonishing set of figures.

I also wonder if 5 percent inflation is not what we need, given political realities. Neither party will balance the budget, and Americans seem loath to vote for a Third Party.

Running 5 percent inflation would help "pay off" the debt over five to 10 years, and help a lot of other people deleverage too.

A few more comments. Wages do not drive inflation, monetary policy does. If inflation turns higher, wages will follow. And if lots of slack kept inflation low, then Argentina would have the lowest rate of inflation in the civilized world. It is definitely possible to have a weak economy and high and rising inflation. Indeed, high and rising inflation almost guarantees that an economy will be weak.

Benjamin: much as I hate the thought, a higher rate of inflation would help get rid of some of the burden of our trillion dollar deficits. But eventually interest costs on the debt would rise significantly. Also, the interest cost of TIPS, which comprise almost 15% of total debt outstanding would rise in lockstep with rising inflation. So inflating our way out of this mess is only a partial solution.

I would love it if sacred cows of both parties got gored and good. But we seem to be in effective paralysis, when it comes to balancing the federal budget, or bringing it down in relation of GDP.

Of course, there are countries that had inflation and recession, and I can remember stagflation in the USA.

Well, we will see. Some say yet another round of housing ready to dump on the market, keeping housing cheap, and factory and office rents are going to stay cheap for several years more. All manufactured goods getting cheaper all the time.

Your recent chart on commodities is an alarm, but who knows how bad yet. And health care and education keep going up.

All around, I just don't see anybody with pricing leverage. I think every business and worker is happy to get business and have a job. That attitude will stay the same for several years.

I am quite willing to concede we could have a round of inflation several years out. Still, we made it all the way through the 1980s, 1990, and now 2000s without any serious inflation. I think there are certain inhibitors built in, such as very solid increases in productivity and labor market softness, and no unions.